Question

Scott is named your new boss at work. When Scott was hired, you were making $50,000 per year. After a year, he decided to give you a 50% raise and you’re now making $75,000 per year.  

From your perspective, economically speaking only, explain under what type of economic circumstance would Scott be considered a very generous boss?  

Under what economic circumstances, from your perspective as the employee, would Scott NOT be considered a generous boss?

How could you explain why Scott could NOT be considered a generous boss if he’s giving you a 50% raise?

FURTHER-

Ask someone one generation (or more) older than you what the cost of their first car or house or salary was years ago. I'm looking for the cost of an item AT LEAST 30 years ago or more.

What I want you to observe is if they relate the price (or income) to the cost of living WITHOUT your input. Most people will say something like "My first house was $45,000." or "My first teaching job was $15,000". They Might even say "things have become so much more expensive but not link that the cost was proportional to their salary. Sure a house was $45,000, but if you're making $15,000 then the house is approximately 3 years of labor (assuming no taxes or other expenses at all.)

Once you've asked this question, please let us know what item they shared, approximately what year it was, and if they INDEPENDENTLY recognized the difference between real and nominal prices.

You're welcome to pick any item you choose - movie, gallon of gas, college, newspaper, etc - whatever makes the conversation more interesting.

Answer 1

Scott is considered as a generous boss if the prices do not increase (taxes, inflation, etc) and he was given a 50% raise. Whereas Scott would not be considered as a generous boss if the prices increase by the same rate (or maybe even higher rate) than the increase in pay!

For example, if the inflation for the next year is 50%, as an employee, I would be indifferent because now would be spending higher amount of money to buy the same goods and the consumption bundle will not change. I would be worse off if there was an increase in inflation and say a raise in taxes; effectively I would be worse off if the rate of change of prices/cost of living is greater than my pay raise.

There’s a famous example quoted by the former governor Raghuram Rajan of Reserve Bank of India, termed as “Dosanomics”, which explains the difference between real and nominal prices.

When Raghuram Rajan was serving as the Governor, retirees often complained that “We were getting 10% on fixed deposits and now we are barely getting 8%; we are not able to get the ends meet.”

When Rajan joined in as the Governor, the inflation was high near to 10% and so were the rate of interest given by the banks. When Inflation came down to less than 5%; the banks also lowered the interest on deposits from 10% to 8%.

The argument went like, “say if there’s a pensioner with a savings of $100,000 who earns an interest rate of 10%. He could buy the dosa today at $50 per piece, that is, he could buy 2000 dosa today. However if the pensioner wants more, he could put his money in the bank and earn 10% (also the inflation rate is 10%), after one year, the price of the dosa increases to 55 (with 10% inflation) he can buy 1818 dosa(100,000/55) and with the additional 10,000 (interest payment @ 10%) he could buy 182 additional dosa (10,000/55). The total he could buy is 1818 + 182 = 2000 dosa.
In the period of low inflation (5%) and low interest rate (8%), the price of dosa is $52.5. The individual can buy 1896 dosa ($100,000/52.5) and with the additional $8000 (interest payment @8%), he could but 152 additional dosa (8000/52.5). The total dosa he could consume is 2048!”

In relation to the above question, if the pay raises by the same level as the cost of living, the individual would be indifferent, however, if all the costs remain the same and the pay raises, the individual would be in a better position. While if the prices increase at rate lower than that of the pay raise, the individual would be better off!